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A: In business, it's not the glint in your eye
that's the tip-off to your competitive ways--it's the price you
charge.

Professor Richard Gilbert, chair of the Competition Policy Center
at the University
of California at Berkeley, tells us that the economics of
competition comes down to the gap between price and costs. "The
closer together these are, the greater the competition," he says.
Businesses prefer a larger margin in order to increase profits,
so there is a natural desire to find ways to limit competition.
In a healthy market, this happens by introducing better products
and services, not by cutting prices.

Given time, the forces of the free market will uncover the
"right" price for a given item. That's all well and good--but not
much help when setting prices for a new offering. For most
businesses, pricing is a combination of covering costs and
tacking on a reasonable profit, then determining what the
competition is able to charge. If the market is perfectly
competitive, all companies will charge the same price for a
similar product. Price above the average, and customers will go
elsewhere; price below it, and you can't afford to stay in
business. Beyond that, there are strategic decisions that could
affect your price point.

First, businesses may want to start with low introductory prices.
"It's a common strategy to do promotional pricing to tell the
world who you are and what you do," Gilbert says. If costs are
likely to fall as more goods are produced and sold, then a low
price that attracts sales can help a business reach greater
profits more quickly.

If a product has network effects--if it becomes more valuable the
more people use it--then a low price can get it into the hands of
more people and help your business set the standard. On the other
hand, a high price can enhance the positioning of a product as a
unique or luxury item.

Companies that sell directly to consumers can set prices as high
as they like, but those that work with distributors need to know
a few things. "Often, firms that sell prestige products don't
want their distributors to cut their price," Gilbert points out,
but it is illegal to dictate a price as a requirement for
carrying an item. The solution is to explain the advantages of
using the suggested retail price. "You might have to help your
distributor help you," he says. A high price that carries a good
margin may encourage distributors to stock your product over that
of the competition.

But what about antitrust laws? "For a new entrepreneur, most of
antitrust is a nonissue," Gilbert says. However, there are always
ways to get into trouble.

"Any business--big or small--can set its prices as it deems
prudent," says William Markham, an antitrust lawyer at San
Diego-based Maldonado & Markham. He says businesses can raise
prices if higher margins offset the reduced demand.
Alternatively, setting prices low in order to entice customers is
fine, but doing so in order to force a competitor out of business
is not.

Markham also says two direct competitors can never agree among
themselves how much they will charge. "The offenders are exposed
to criminal punishment, including even prison sentences and
massive fines, and they are further exposed to civil litigation
and administrative proceedings," he warns.

Price fixing doesn't always involve top-level executives at
smoky, secret meetings. In 2008, the FTC charged a physician's
group in Boulder, Colo., with encouraging members to collude in
their negotiations with health insurance companies. In 1998,
hotels in the South Lake Tahoe Lodging Association ran afoul of
the law when they collectively agreed not to post signs
advertising room rates.

Now that you've been warned against getting too cozy with the
competition, keep in mind that you also have to be careful about
going head-to-head with them. Though acknowledging that it's
"always nice to know what your competitors are up to," Berkeley's
Gilbert says to avoid veering into industrial espionage. Checking
out prices in stores is fine; stealing a competitor's sales
documents is not. In sum, he tells us, "You're not supposed to
break the law, even if it's in the service of good old
capitalism."